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The Third Time is a Charm
(Washingtonâs October Surprise Part 1)
Tax and Financial News
November 2004
The Third Time is a Charm
(Washingtonâs October Surprise Part 1)
Had he been alive today, President Regan may have said something like, "There you go again," on October 22, 2004 when President Bush signed into law The American Jobs Creation Act of 2004 ("AJCA"). Believe it or not, this was the third major tax bill in 2004 - and you thought Congress didnât work very hard - and it enacted sweeping reforms in business taxation in the United States. The other two significant laws enacted in 2004 were the Working Families Tax Relief Act of 2004 ("WFTRA"), which made certain provisions scheduled to expire in the future permanent, and the Pension Funding Equity Act of 2004 ("PFEA"), which amended certain provisions of the Internal Revenue Code dealing with retirement plans.
What is utterly amazing is that Washington managed to do all of this and only increase the deficit over the next ten years by $140 billion. This was accomplished by offsetting tax decreases in the AJCA and PFEA by revenue raisers that will basically make up for lost revenue.
So, whatâs in "AJCA" for the individual taxpayer? That depends mainly on how you define the individual. For those with W-2 income and a few itemized deductions, this latest act wonât affect you much. However, if you are a business owner and plan on buying a new Hummer before the end of the year, we need to talk.
The Good News
In the distant past, individuals were able to deduct the state income tax they paid, any personal and real property taxes they paid and sales taxes they paid. It was a taxpayer heaven - you were only taxed on income once instead of paying tax on taxes. In the 1980s, the ability to deduct sales taxes paid was eliminated from the Internal Revenue Code. For those taxpayers who lived in states with no income tax, this was perceived as unfair.
Whether eliminating the deduction for sales taxes really was unfair to certain taxpayers is now a moot point - for the next two tax years. Effective for years beginning on or after December 31, 2004 and years beginning before January 1, 2006, taxpayers will be allowed to deduct the larger of their state income tax or sales tax. To determine the sales tax amount, you can use either the actual taxes paid based on your original receipts or a standard amount reflected on a table to be developed by the Internal Revenue Service. The table will be tied to your income.
The obvious planning opportunity with this new law is to do all you can to maximize your deductions each year through "bunching." For example, letâs assume you itemize and you know you will need to purchase two $25,000 vehicles over the next two years and sales tax will be $2,000 on each vehicle. Letâs further assume your cash state income tax expense will be $2,500 each year.
If you purchase one car in 2004 and one in 2005 along with paying your $2,500 tax bill in each of those years, your itemized deductions for the greater of sales or income taxes will be $2,500 in each year. Overall, you will benefit from only $5,000 in deductions. How would you feel about waiting until 2005 to purchase both vehicles? Doing this, you will get a $2,500 deduction for income tax in 2004 and a $4,000 deduction for sales tax in 2005. Thatâs an additional deduction of $1,500, which translates into real tax savings.
The Not So Good News
Whatever happened to the good old days when you could put a number on your return and the government would believe you without a receipt? Oops, that was a dream I had last night. Actually, to some extent, you used to be able to do this when you donated your used car, trailer, etc. to your favorite charity. Until now, you had the ability to use the Blue Book value as your deduction. For donations made after December 31, 2004, the deduction for any donation greater than $500 will be the gross amount received by the charity upon the sale of the vehicle. Given that the Blue Book retail value of most vehicles is higher than the actual cash price received by the charity; this will have the effect of decreasing most deductions.
If the vehicle is not sold, the charity must provide documentation as to the intended use of the vehicle and duration of use. All documentation must be contemporaneous.
The Really Bad News
Sometimes, one day can make all the difference in the world. That $65,000 SUV that you put in service on October 22, 2004 could be basically written off in the first year, if certain conditions of weight and use were met. Unfortunately, too much of a good thing wasâ¦wellâ¦too much for many Congressional constituents. Therefore, on October 23, 2004, that SUV that weighed over 6,000 pounds gross vehicle weight but less than 14,000 pounds gross vehicle weight became a limited species. Any such purchase after the date of the AJCA enactment will have a Code Section 179 expense maximum of $25,000. Fortunately, this limitation does not apply to the 50 percent bonus depreciation.
For example, say you did buy a $65,000 SUV that has a gross loaded vehicle weight of 6,150 pounds on November 1, 2004. The vehicle is used 100 percent for business. You would have the following maximum deduction:
Under the old laws, the first year deduction would have been $65,000 assuming the full $100,000 deduction was available for this vehicle.
Concluding Thoughts
We have covered only three provisions of the AJCA, but there are many others. Most related to business deductions, like our SUV bombshell, but many of the revenue raisers will affect individuals through tougher enforcement of current penalties as well as adding penalties. The law is complex and it is to your advantage to sit down and determine if you will be affected. Give us a call today so we can schedule a time to help you make the most of your opportunities under Washingtonâs October Surprise.
Have a great November and remember to exercise your right to vote.
What is utterly amazing is that Washington managed to do all of this and only increase the deficit over the next ten years by $140 billion. This was accomplished by offsetting tax decreases in the AJCA and PFEA by revenue raisers that will basically make up for lost revenue.
So, whatâs in "AJCA" for the individual taxpayer? That depends mainly on how you define the individual. For those with W-2 income and a few itemized deductions, this latest act wonât affect you much. However, if you are a business owner and plan on buying a new Hummer before the end of the year, we need to talk.
The Good News
In the distant past, individuals were able to deduct the state income tax they paid, any personal and real property taxes they paid and sales taxes they paid. It was a taxpayer heaven - you were only taxed on income once instead of paying tax on taxes. In the 1980s, the ability to deduct sales taxes paid was eliminated from the Internal Revenue Code. For those taxpayers who lived in states with no income tax, this was perceived as unfair.
Whether eliminating the deduction for sales taxes really was unfair to certain taxpayers is now a moot point - for the next two tax years. Effective for years beginning on or after December 31, 2004 and years beginning before January 1, 2006, taxpayers will be allowed to deduct the larger of their state income tax or sales tax. To determine the sales tax amount, you can use either the actual taxes paid based on your original receipts or a standard amount reflected on a table to be developed by the Internal Revenue Service. The table will be tied to your income.
The obvious planning opportunity with this new law is to do all you can to maximize your deductions each year through "bunching." For example, letâs assume you itemize and you know you will need to purchase two $25,000 vehicles over the next two years and sales tax will be $2,000 on each vehicle. Letâs further assume your cash state income tax expense will be $2,500 each year.
If you purchase one car in 2004 and one in 2005 along with paying your $2,500 tax bill in each of those years, your itemized deductions for the greater of sales or income taxes will be $2,500 in each year. Overall, you will benefit from only $5,000 in deductions. How would you feel about waiting until 2005 to purchase both vehicles? Doing this, you will get a $2,500 deduction for income tax in 2004 and a $4,000 deduction for sales tax in 2005. Thatâs an additional deduction of $1,500, which translates into real tax savings.
The Not So Good News
Whatever happened to the good old days when you could put a number on your return and the government would believe you without a receipt? Oops, that was a dream I had last night. Actually, to some extent, you used to be able to do this when you donated your used car, trailer, etc. to your favorite charity. Until now, you had the ability to use the Blue Book value as your deduction. For donations made after December 31, 2004, the deduction for any donation greater than $500 will be the gross amount received by the charity upon the sale of the vehicle. Given that the Blue Book retail value of most vehicles is higher than the actual cash price received by the charity; this will have the effect of decreasing most deductions.
If the vehicle is not sold, the charity must provide documentation as to the intended use of the vehicle and duration of use. All documentation must be contemporaneous.
The Really Bad News
Sometimes, one day can make all the difference in the world. That $65,000 SUV that you put in service on October 22, 2004 could be basically written off in the first year, if certain conditions of weight and use were met. Unfortunately, too much of a good thing wasâ¦wellâ¦too much for many Congressional constituents. Therefore, on October 23, 2004, that SUV that weighed over 6,000 pounds gross vehicle weight but less than 14,000 pounds gross vehicle weight became a limited species. Any such purchase after the date of the AJCA enactment will have a Code Section 179 expense maximum of $25,000. Fortunately, this limitation does not apply to the 50 percent bonus depreciation.
For example, say you did buy a $65,000 SUV that has a gross loaded vehicle weight of 6,150 pounds on November 1, 2004. The vehicle is used 100 percent for business. You would have the following maximum deduction:
| ⢠Section 179 deduction | $25,000.00 |
| ⢠50 percent bonus depreciation | $20,000.00 |
| ⢠Regular MACRS depreciation (half-year convention) | $4,000.00 |
| Â | Â |
| Total first-year deduction | $49,000.00 |
Under the old laws, the first year deduction would have been $65,000 assuming the full $100,000 deduction was available for this vehicle.
Concluding Thoughts
We have covered only three provisions of the AJCA, but there are many others. Most related to business deductions, like our SUV bombshell, but many of the revenue raisers will affect individuals through tougher enforcement of current penalties as well as adding penalties. The law is complex and it is to your advantage to sit down and determine if you will be affected. Give us a call today so we can schedule a time to help you make the most of your opportunities under Washingtonâs October Surprise.
Have a great November and remember to exercise your right to vote.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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